Three magic numbers you need to know

John Nyaradi is Publisher of
Wall Street Sector Selector, a financial media site focused on news,
analysis and information about exchange traded funds and global financial and
economic developments.
John's investment articles have appeared in many online publications including
MarketWatch, Trading Markets, Money Show, Yahoo Finance, Investors Insight,
Fidelity, ETF Daily News, iStock Analyst and his interviews have appeared on
MarketWatch, Yahoo Finance's Breakout, National Business Talk Radio, Sound
Investing, and The Index Investing Show. His book, "Super
Sectors: How to Outsmart the Market Using Sector Rotation and ETFs", is
included among the Years Top Investment Books in the 2011 Stock Trader’s
Almanac.

These three numbers represent all-time closing highs for the two major U.S. stock indexes, and together, they form the largest triple top of our time.

One doesn't have to be a charting expert to see the significance of these "magic numbers" and the extreme resistance they represent. A sustained break above these levels would clearly set the stage for a new leg up, while failure here could lead to significant retracements similar to those seen in 2000 and 2008.

As of Tuesday's close, the S&P 500 is roughly 3.6% from its all-time closing high, while the Dow Jones Industrial Average is a scant 1.3% from its all-time high.

As the possibility for new highs and a sustainable bull market come into view, the average retail investor, who has been shunning stocks for years, now appears to be getting excited about investing in equities again.

During the first three weeks of January, long-term mutual funds (excluding money-market funds) attracted inflows of $64.8 billion, according to The Investment Company Institute. This total exceeded the $52.6 billion for the entire month of May 2009, which had been a record since the ICI began tracking this data in 1984.

Furthermore, equity mutual funds pulled in more money (possibly more than $90 billion in the final count) in January, more than in any month since 2006, and more money is flowing into stock funds than bond funds for the first time since the onset of the financial crisis in 2007.

So is this the sign of a nascent bull market and the return of a golden age in equities or the mark of another top having been reached and a new decline straight ahead?

The bulls argue that economic reports point to a favorable investing environment as recent economic reports have been largely positive:

January's University of Michigan Consumer Sentiment Index rose to 73.8 from Decembers 72.9.

January's Institute for Supply Management's (ISM) Manufacturing Index jumped to 53.1%, again beating expectations, to land in solid expansion territory.

January's Non-Farm Payrolls Report indicated that 157,000 new jobs were created in January along with significant increases to November's and December's initial estimates.

On the other side of the fence, the bears argue that there is no way the major U.S. indexes can surpass old highs:

Europe is entering recession, and the slowdown there could easily ripple ashore in the United States.

Japan is in recession and so another major trading partner will likely be a drag on the U.S. expansion.

Fourth-quarter U.S. GDP contracted at an annualized rate of 0.1%, despite economists' expectations that GDP increased by 1.1%.

Government spending seems set to decline, either through sequestration or political agreement, and this will further retard U.S. economic growth.

Technical factors point to an overbought, overextended market. Relative strength is near overbought territory, momentum is slowing and the markets now face resistance levels stretching back for more than a decade.

Bullish investor sentiment is running well above average levels, (48% vs. 39%) according to the American Association of Individual Investors, which is typically a bearish indicator.

As the hyperbole surrounding Dow 14,000 grows and bullish commentary becomes shriller, investors should pay heed to the three "magic numbers" on the S&P 500 and Dow Jones Industrial Average. Until those levels are in the rearview mirror, nothing of substance has occurred. Has the "dumb money" successfully called the top again, or are we at the dawn of a new age for equities? Only time will tell, but for today, Wall Street Sector Selector remains in "Yellow Flag" status, expecting consolidation or correction ahead.

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